There’s a reason the stock market doesn’t like higher bond yields, and it has a lot to do with the burgeoning levels of government debt. Treasury yields fell Tuesday , but the benchmark 10-year note remained above the psychologically important 3% level, a red line for investors who are sensitive to persistent inflation pressures and accompanying higher rates. One reason the higher rates matter so much is that the government is carrying a $30.4 trillion debt load , which low interest rates are a key to managing. Total public debt is now about 125% of GDP, or more than four times where it was in the early 1980s, the last time inflation was running this high. Debt service alone on the federal debt reached $514.8 billion in 2021. In the days of the Volcker Federal Reserve in 1980, debt service totaled $107.5 billion. Interest rates were much higher then, something the market is wary of when contemplating the impact rising yields could have on government and private finances. “Neither the U.S. government nor private business can afford +10 percent Treasury/corporate debt yields. Those were commonplace in the 1970s; they would be very damaging now,” DataTrek Research co-founder Nicholas Colas said in his market note late Monday. “This is why we say the famous ‘Fed Put’ has shifted from stocks to the Treasury market. [Fed Chair Jerome Powell] and the FOMC know that they must keep structural inflation at bay and Treasury yields low. Much, much lower than the 1970s.” The Fed currently plans on instituting 100 basis points of rate hikes over the summer, likely followed by more increases, though at a slower pace, later in the year. Market pricing is for the fed funds rate to end 2022 in the 2.75%-3% range. Anything more than that could start to get scary. “We think this is one reason U.S. equity markets get into trouble when Treasury yields hit 3 percent,” Colas wrote. “That was the case in Q4 2018, and the same is true now. It’s not that a 3 percent cost of risk-free capital is inherently unmanageable, either for the Federal government or the private sector. Rather, it is the market’s way of signaling the manifold uncertainties if rates don’t stop at 3 percent, but instead keep rising.”
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